Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $385,000 is estimated to result in $145,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $45,000. The press also requires an initial investment in spare parts inventory of $20,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 22 percent and its discount rate is 9 percent. Refer to Table 10.7. Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Calculation of NPV of project
Year	0	1	2	3	4
Investment in new machine press	-$385,000.00
Investment in spare parts inventory	-$20,000.00	-$3,100.00	-$3,100.00	-$3,100.00
Annual pretax cost savings		$145,000.00	$145,000.00	$145,000.00	$145,000.00
Tax @ 22% of pretax cost savings		-$31,900.00	-$31,900.00	-$31,900.00	-$31,900.00
Depreciation tax shield		$16,940.00	$27,104.00	$16,262.40	$9,757.44
Recovery of investment in spare parts inventory					$29,300.00
After tax sale value of equipment					$49,736.16
Net Cash flow	-$405,000.00	$126,940.00	$137,104.00	$126,262.40	$201,893.60
x Discount factor @ 9%	1.00000	0.91743	0.84168	0.77218	0.70843
Present Value	-$405,000.00	$116,458.72	$115,397.69	$97,497.74	$143,026.52
Net Present Value of Project	$67,380.67
Working
Calculation of depreciation using 5 Year MACRS and depreciation tax shield
Year	Depreciable value	Depreciation rates	Depreciation	Depreciation tax shield @ 22%
1	$385,000.00	20.00%	$77,000.00	$16,940.00
2	$385,000.00	32.00%	$123,200.00	$27,104.00
3	$385,000.00	19.20%	$73,920.00	$16,262.40
4	$385,000.00	11.52%	$44,352.00	$9,757.44
Calculation of after tax sale value of new machine press
Sale value	$45,000.00
Less : Book value of new machine press at the end of project [$385000 - $318472]	$66,528.00
Loss on sale of new machine press	-$21,528.00
Tax benefit @ 22% of loss on sale	$4,736.16
After tax sale value [Sale value + Tax benefit]	$49,736.16